a. You expect an RFR of 10 percent and the market return (RM) of 14 percent. Compute the expected return for the following stocks, and plot them on an SML graph. Stock Beta E(Ri) U 0.85 N 1.25 D -0.2 b. You ask a stockbroker what the firm's research department expects for these three stocks. The broker responds with the following information: Stock Current Price Expected Price Expected Dividend U 22 24 0.75 N 48 51 2 D 37 40 1.25 Plot your estimated returns on the graph from part (a) and indicate what actions you would take with regard to these stocks. Explain your decisions.
a. You expect an RFR of 10 percent and the market return (RM) of 14 percent. Compute the expected return for the following stocks, and plot them on an SML graph. Stock Beta E(Ri) U 0.85 N 1.25 D -0.2 b. You ask a stockbroker what the firm's research department expects for these three stocks. The broker responds with the following information: Stock Current Price Expected Price Expected Dividend U 22 24 0.75 N 48 51 2 D 37 40 1.25 Plot your estimated returns on the graph from part (a) and indicate what actions you would take with regard to these stocks. Explain your decisions.
Chapter8: Analysis Of Risk And Return
Section: Chapter Questions
Problem 15P
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Concept explainers
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Question
| a. You expect an RFR of 10 percent and the market return (RM) of 14 percent. Compute the expected return for the following stocks, and plot them on an SML graph. |
| Stock | Beta | E(Ri) |
| U | 0.85 | |
| N | 1.25 | |
| D | -0.2 |
| b. You ask a stockbroker what the firm's research department expects for these three stocks. The broker responds with the following information: |
| Stock | Current Price | Expected Price | Expected Dividend | |
| U | 22 | 24 | 0.75 | |
| N | 48 | 51 | 2 | |
| D | 37 | 40 | 1.25 |
| Plot your estimated returns on the graph from part (a) and indicate what actions you would take with regard to these stocks. Explain your decisions. |
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